Wednesday, 26 October 2016

The (investment) world turned upside down

These are just a few initial sketchy thoughts, but I see some signs that something interesting is starting to happen in the world of corporate governance, and institutional investment more generally. A couple of years back I blogged a bit about a "regulatory turn" away from shareholder primacy, as, in response to the financial crisis, governments became much more sceptical about shareholder oversight as restraint on corporates and looked for other options. But overt change hasn't happened until now.

The mood music has been right for a while. A few people have clocked John Kay's claim that the era of shareholder value is closing. Justin Fox was riffing on a similar theme a couple of years back. I think we might be now seeing the first policy moves that diminish the relative position of shareholders.

To take a pretty bland example, the abolition of quarterly reporting by companies is the one thing that all "sensible" people agree should happen. Here's the CEO of Morgan Stanley on this theme just yesterday. But, if you think it through, if getting rid of quarterlies does have an impact - through reducing short-term pressure on companies - this means that investors were using the information, for example in response to analysts' takes on the numbers.

So its disclosure was not pointless, the numbers are/were being used by investors, we are just uncomfortable with the impact this was having on companies. So to get rid of quarterlies is essentially tilting the system a bit back towards companies and a bit away from investors.

We can see something similar at work in the emerging discussion over worker representation on boards that is taking place in the UK. To be honest, this has been creeping up the agenda for a while, the shock about it is that it is the Tories who are actually making it happen. If you look back to last year's party manifestos Labour, the Lib Dems, the SNP, Plaid and the Greens all committed to worker representation on boards. This is more than a detail - it shows that there is no political constituency opposed to workers on boards.

However you cut it, having worker and consumer representation on the board of a PLC strengthens the relative position of stakeholders other than investors. I know the government has talked about a further binding shareholder vote on pay in the same breath, but personally I'd take board representation over tweaked powers (that many asset managers probably won't use effectively) any day.

Possibly the most interesting aspect of the workers on boards debate is the relative lack of criticism from business. Perhaps this because no-one wants to be seen to be opposed to the idea now it looks like the government is going for it, perhaps they are sill shocked by the Brexit vote, and perhaps they are lobbying frantically against - or at least for a milder version - in private. But in public in the tone has been pretty mild. This round-up in the FT is very illustrative.

It will be very interesting to see which way the CBI jumps on this. Perhaps its members are willing to tolerate stakeholder representation in return for less shareholder pressure? We do tend to forget in the UK that there are other corporate governance models out there and that they too are capable of delivering successful businesses whose leaders seem comfortable with it. Perhaps, just perhaps, companies will review the merits of the New Industrial Compact that Tony Golding describes emerging in the 80s and 90s (I included his description of it here).

But that's only half the story. Look at what is happening in institutional investment. After years of getting fleeced, our pension funds are starting to look at whether the billions they pay over to intermediaries is well spent. And many are concluding that it is not. Big funds in the UK, US, Netherlands and elsewhere are cutting their exposure to high-fee hedge funds and private equity managers, cutting the total number of external managers and investing more on a passive basis. This is quite a sharp shift from the positions some groups in the UK took pre-crisis. (and I take my hat off to Mr Meech at Unison for making costs and charges in the investment system an issue for the labour movement, and for stirring Labour out of inaction on this too.)

These moves also open up some interesting issues. For example, if our pension funds invest an increasing proportion of our assets passively then they are giving up on the idea that whatever insight asset managers have this is insufficient to generate outperformance. They are simply seeking exposure to the market in aggregate. To boil this down further, our pension funds expect public companies overall to generate returns, but they do not think it is possible and/or worthwhile to pay an intermediary to identify which companies will perform better.

In such a scenario, where our pension funds do not believe asset managers have insight into companies that is worth paying for, there is no reason why our funds should delegate their voting rights. More fundamentally, if they are giving up on the idea of stock picking, there is no reason for a fund's RI policy to be squeezed by the constraints of trying to develop a case for doing the right thing. that is justified by relative performance. Instead, provided that trustees believe that, for example, companies respecting human rights will not damage investment returns, their RI policy could be based on the promotion of international norms. This is much preferable to fashioning some blah about long-term returns to act as cover for engagement that is really about values.

I will chuck out a point here that I have made before too. These are OUR pension funds. They are not the personal fiefdoms of CIOs and other investment staff any more than asset managers. So it is reasonable for us to expect that these policies promote the interests of beneficiaries. It is great that funds are starting to clamp down on wasteful costs and charges that eat into our retirement income. Now lets make sure these funds work in our interests while we are at work in addition to when we are retired. This means as much emphasis on the S as on the E and G, and more focus on workplace issues in particular.

Overall, there is a real opportunity for the Left here if we think big. If confidence is failing in shareholder primacy then we should be on the front foot in setting out what a good alternative is. Forget the tinkering with corporate disclosure & shareholder powers that characterised the New Labour settlement. What does a stakeholder model of the company look like in the 21st century? And what is our vision of an investment system that both delivers a decent income in retirement and promotes our interests in the accumulation phase?

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